@vartec But the answer might be different in different jurisdictions.
–
DJClayworthFeb 22 '12 at 16:23

2

Even if it were true legally, exactly how would you know the company had not maximised returns? And how would you trade off certain returns today for uncertain returns in the future?
–
matt_blackFeb 22 '12 at 21:21

3

and maximise over what timeframe? It's easy to maximise over a single quarter, just sell everything, leaving the company a shell that will go bankrupt as the shareholders are paid out (which sometimes indeed happens). However good "corporate stewardship" would attempt to create a sustained decent profit in the long term, which generates more total income for the shareholders as well (those that don't sell their shares rapidly that is). As matt says, that's impossible to measure.
–
jwentingFeb 23 '12 at 8:20

5 Answers
5

No. Because the idea itself is too poorly defined and naive interpretations are often bad for shareholders in practice

If the legal obligation to maximize profit for shareholders existed we would have to develop a good definition of how is is to be measured. Alas there isn't even a unique way to summarize a stream of known cash payments over time into a single current value (the net present value calculation yields different results for different discount rates). The standard way of thinking about quoted company values which claims to resolve the problem of which discount rate to choose (the capital asset pricing model) has serious problems despite its wide acceptance (well summarized by wikipedia).

Many of the issues come down to a judgement call about making an costly investment now for higher profits in the future or just giving the cash to shareholders instead. This is a hard matter of judgement and coping with uncertainty in the future.

The Shareholder Value movement has been influential in promoting the idea that cashflow to shareholders should be the focus of senior management in quoted companies. The movement has led to some beneficial changes in business practice, but has also led many leaders to become overly obsessed with their share prices. As John Kay (a british economist and commentator) has pointed out:

Managers who focus closely on the stock price, whether by inclination or because they have incentives to do so, will often fail to serve the best interests even of their stockholders.

In another of his regular columns in the Financial Times he describes his own journey with the idea of shareholder value:

In my academic life, I taught the standard concepts of modern economic theory, based on efficient markets populated by maximising agents. Yet, as I saw more of successful businesses, I understood that they didn’t maximise anything. Such businesses were complex political organisms: they contained and were influenced by diverse individuals and groups with diverse goals, and the effective manager was someone who could mediate between these conflicting forces. If these companies talked about shareholder value – and increasingly they did – it was an instance of Franklin’s Gambit, a legitimising rhetoric rather than a real guide to action.

And the more shareholder value became a guide to action, the worse the outcome. On the board of the Halifax Building Society, I voted in 1995 for its conversion to a “plc”. We would allow the company to pursue the goal of maximising its value untrammelled by outmoded concepts of mutuality: in barely a decade, almost every last penny of that value was destroyed. In 1996, as my thoughts on this began to form, I went to the CBI annual conference and described how ICI, for decades Britain’s leading industrial company, had recently transformed its mission statement from “the responsible application of chemistry” to “creating value for shareholders”. The company’s share price peaked a few months later, to begin a remorseless decline that would lead to its disappearance as an independent company.

...These unanticipated results reflected the profit-seeking paradox, well described in James Collins and Jerry Porras’s fine book Built to Last: the most profitable companies were not the most profit-oriented.

As he summarizes:

the idea that good decisions are the product of orderly processes – is more alive than ever in public affairs.
...There is not, and never will be, such a science. Our objectives are typically imprecise, multifaceted and change as we progress towards them – and properly so. Our decisions depend on the responses of others, and on what we anticipate these responses will be. The world is complex and imperfectly known, and this will remain true however much we analyse it.

And this summary explains why the idea of "maximizing" profit is not a sensible objective in itself: the world is too complex and no formula can reduce it to a meaningful value.

Update

A recent Washington Post blog includes some useful references and commentary. For example, the blog argues:

this supposed imperative to “maximize” a company’s share price has no foundation in history or in law. Nor is there any empirical evidence that it makes the economy or the society better off. What began in the 1970s and ’80s as a useful corrective to self-satisfied managerial mediocrity has become a corrupting, self-interested dogma peddled by finance professors, money managers and over-compensated corporate executives.

And:

There are no statutes that put the shareholder at the top of the corporate priority list. In most states, corporations can be formed for any lawful purpose. Cornell University law professor Lynn Stout has been looking for years for a corporate charter that even mentions maximizing profits or share price. She hasn’t found one.

Nor does the law require, as many believe, that executives and directors owe a special fiduciary duty to shareholders. The fiduciary duty, in fact, is owed simply to the corporation, which is owned by no one, just as you and I are owned by no one — we are all “persons” in the eyes of the law. Shareholders, however, have a contractual claim to the “residual value” of the corporation once all its other obligations have been satisfied — and even then directors are given wide latitude to make whatever use of that residual value they choose, as long they’re not stealing it for themselves.

I totally agree with everything you said. But it does not answer the question of is it required. You address why it is a bad idea to require that from a standpoint of anyone who wants to see a business succeed, which would presumably include the government.
–
ChadFeb 24 '12 at 19:00

2

As a general principle of legislative interpretation, there can be no criminal or regulatory obligation where that obligation is too vague, and on that basis I tend to agree with this answer. In the US this manifests itself under a constitutional concept called "Void for Vagueness", and most other common law countries have an analogous concept. This concept applies only to criminal/regulatory laws, and says nothing of civil disputes between private parties, such as shareholders and directors (which civil liability probably begot this myth).
–
Brian M. HuntFeb 24 '12 at 19:28

@Chad I admit i'm only attempting a partial answer based on the idea that "maximising value" is self contradictory. So it is only a partial answer and ignores the possibility that managers could be clearly derelict in a way that would break any such law. Mostly, though, maximising is meaningless.
–
matt_blackFeb 24 '12 at 21:49

Are you saying that a majority of the shareholders could decide via a vote to give 90% of the assets of the company to some charity to fight malaria?
–
ChristianJun 11 '12 at 14:27

@Christian Shareholders don't need to do that: they could just give their shares to charity, which is more direct and effective (Warren Buffet and Bill Gates have done it that way). But if the directors chose to do this without approval, the shareholders might have a justified complaint. The law prevents obvious and gross acts where directors give away value, but isn't effective at controlling their general judgement or goal.
–
matt_blackJun 12 '12 at 20:33

Not directly, but often conditions surrounding corporations lead to this obligation

I've been searching for the answer to this question some time ago, and I found this wonderful LinkedIn thread on the exactly the same issue. So while I'm no lawyer, let me try to explain my findings:

The situation in the US is like this. First, there is a business judgement rule, which says:

directors of a corporation . . . are clothed with [the] presumption,
which the law accords to them, of being [motivated] in their conduct
by a bona fide regard for the interests of the corporation whose
affairs the stockholders have committed to their charge

This implies that directors must do the best for the corporation. Corporations, in turn, seek to maximize the value for the shareholders because if they don’t, the shareholders will exercise their right to replace management. In 99% of the cases, all what the shareholders want is profit (especially in listed companies, where most shareholders don't really say anything at all). So in the end, you get the legal obligation from directors to maximize profit.

However, if shareholders agreed that it's not only profit that matters, you get a different picture.

You will find further arguments in the thread linked above, yet most of it will be opinions without references.

What does "if shareholders agreed" mean? A majority of them votes a certain way? All of them vote a certain way?
–
ChristianJun 11 '12 at 14:26

@Christian it depends on the articles of the company, I guess. In most cases, I assume, it should simply be the majority of them.
–
AurimasJun 12 '12 at 7:53

1

If your answer is "I guess", I wouldn't trust to much in your whole answer. There a principle called shareholder primary with is supposed to protect minority shareholders. There a people who think that this legal protection for minority shareholders constitutes a requirement for corporations to maximize profits. I think a good answer to the question should explain why 'shareholder primacy' works or doesn't work that way.
–
ChristianJun 12 '12 at 12:51

The short answer is no. They don't get punished for not maximizing shareholder value. But it is true that maximizing value needs to be their goal and they may not be negligent in the pursuit of that goal.

Fiduciary Responsibility

The reason the law is this way is that everyone else who deals with a corporation has their own legal rights: Suppliers, employers, customers, etc.

A business corporation is organized and carried on primarily for the
profit of the stockholders. The powers of the directors are to be
employed for that end. The discretion of directors is to be exercised
in the choice of means to attain that end, and does not extend to a
change in the end itself, to the reduction of profits, or to the
nondistribution of profits among stockholders in order to devote them
to other purposes.

This is built into most legal systems, and is intended to prevent directors managing companies for their own benefit, rather than the owners or shareholders. However it doesn't have to be interpreted narrowly, such as maximizing share price at a given time. Also if a company is explicitly set up for some purpose other than maximizing profit then the directors must work towards that purpose. In many jurisdictions it is explicitly written into law that directors must take into account factors other than profit. For example the UK Companies Act 2006 lays down specific factors that a director must take into account in their decisions.

If a company is publicly traded then the SEC does have some requirements mostly that require accurate reporting but none that require the company actually attempt to make a profit.

Most shareholders want a Return on Investment however you do not need to maximize profit to make a return on investment. A shareholder can vote to remove the board or any officers so generally they work to keep an acceptable ROI though stated goals. Though no law actually enforces that the company persue those goals nor does the law penalize those companies for not attempting to persue them so long as they do not attempt to represent that they are(commit fraud).

A perfect example of this would be the American Red Cross it is a business lead by a CEO but operates as a non profit entity. While there are some specific things that the Red Cross has been chartered to do by law it operates independently and manages its finances as a business.

This answer is mostly besides the point and is misleading. The question of corporate personhood is orthogonal to the issue of director/corporate liability to shareholders. Directors have a fiduciary duty to the "company" (in some places) or shareholders (in others), and the extent of that duty may require directors to make decisions (as the "directing mind") that result in higher profits at the expense of other considerations (eg the environment, good faith, etc.). The phrase "maximization of profits" is an oversimplification of the duties of the directing mind.
–
Brian M. HuntFeb 22 '12 at 22:13

@BrianM.Hunt There is a difference between a duty(what is expected) and a legal requirement. This answer deals with the criminal legal and regulatory obligations. This is not about their responsibility to the shareholders, employees, or any other third party.
–
ChadFeb 23 '12 at 13:31

1

A fiduciary duty is a legal obligation, breach of which can give rise to civil liability. As well, the question is about the duty of a company to shareholders, but of course a "company" (the legal fiction) only makes decisions by way of its directing mind (a collection of human beings). Save edge cases where there is a structural requirement in the articles of incorporation or by-laws, the fiduciary duty owed by directors may help explain the basis for the perception of a duty described in the question.
–
Brian M. HuntFeb 23 '12 at 14:21

@BrianM.Hunt - You do not go to jail for that. And there are no penalties for failure to meet a fiduciary responsibility by statute... Any civil recourse would be a part of the contract for the CEO, or other officers which would bear that responsibility. Those legal obligations would be contractual not statutory I would infer from the question.
–
ChadFeb 23 '12 at 20:16

1

Failure to maximize profits is almost certainly not a criminal or even a regulatory offence. But I don't know the US securities regulations well. I expect that the motivation for directors & companies to maximize profits is based on the prospect of civil liability to shareholders, which liability could be contractual, but most likely arising out of a species of common-law fiduciary duty or breach of trust. I'm not sure prison is a consideration in the question, only whether there is a "legal obligation".
–
Brian M. HuntFeb 23 '12 at 21:34